Mind over markets

Did you know that tulips didn’t originate in the Netherlands? These spring blooming flowers may have become symbolic of Holland, but they were actually introduced to the country by the Ottoman Empire in the late 16th century. By the early 17th century, tulips had become a symbol of wealth and prestige in Dutch society. As demand for tulip bulbs grew, so did their prices. Cue an increasingly speculative market, in which people bought, sold and even engaged in futures contracts for tulip bulbs, agreeing to buy tulips at a set price at a later date.

The value of certain rare tulip bulbs reached incredible heights. By the peak of ‘Tulip Mania’ in 1636, a single rare tulip bulb could sell for tens of thousands of guilders, which at the time was equivalent to several years’ worth of wages for skilled labourers. The speculation surrounding tulip prices became more extreme as people, from artisans to farmers and servants, became involved in buying and selling bulbs. At its peak, some bulbs were exchanged for amounts that could buy large houses, and futures contracts were being traded like stocks.

In February 1637 the tulip market suddenly collapsed. It has been widely recorded that a shift in market sentiment and the sheer unsustainable nature of speculative prices led to the downfall. Buyers were no longer willing to pay inflated prices, and the market quickly spiralled downward. Many people were left with tulips worth a fraction of what they had paid for them, and entire fortunes were lost. While the collapse of the tulip market did not lead to a broader economic collapse in the Netherlands, it caused significant financial distress for those who had speculated heavily.

A few years on, the ‘South Sea Bubble’ evidenced that the emotive investing behind 'Tulip Mania' was far from a one-off. In 1711, a British joint-stock business, The South Sea Company, was founded to trade in the Spanish South American colonies. A primary target was the Spanish Empire, which had a monopoly on trade in the Americas at the time. The company was granted exclusive rights to trade with the Spanish colonies in exchange for assuming a large portion of Britain’s national debt. The South Sea Company appeared to be highly profitable with promising prospects. As human emotions such as greed and fear took hold, another 'herd mentality bubble’, where an asset is priced far beyond its intrinsic value, was created.

It soon emerged that the company’s trading ventures were limited and unprofitable. Its assumed performance had been heavily reliant on unfounded speculation, financial manipulation and market hype and therefore, the bubble burst. Investors panicked, stock prices plummeted and this sparked multiple bankruptcies. Public confidence in the financial system was shattered.

Today, we are much more aware of the weight that psychological and emotional factors have on our decisions. Although, it’s clear from modern-day crises such as the 1990s 'Dot-Com Bubble' and the 'Housing Bubble' of the early 2000s that the markets continue to be vulnerable to the human psyche.

However, all is not lost. Stephen explains, “It’s possible to train your brain to be able to combat these natural urges. Investment experience and reading can certainly help. I apply a three-pronged approach to investing. By focusing on quantitative models, building psychological understanding and deep diving into robust research into these investments, investors can make sound decisions.”

So, how do we keep a clear head when markets are moving? “Avoid reading dramatically written, short-termism information such as newspapers,” Stephen says. 

“The headlines are designed to attract attention rather than give you an informed opinion. Tempting as it may be, investors should spend less time looking at their portfolio valuations and avoid selling investments for no other reason than they have underperformed for a period, without researching why and what could change and what the valuation is looking like. Never buy hot tips from a friend as these can often be ill informed.”

Stephen points out that selling last year’s fund laggards in order to buy last year’s winning stock may seem gratifying, but this is likely to reduce your returns over time. “The stellar returns from thematic funds present themselves when they are small. It is only after delivering these returns that funds tend to attract attention, so investors buying in at that point are likely to generate a loss. Even quality companies should be sufficiently researched as paying too much for a stock can still be a bad investment.”

Resilience is key, Stephen says. “As John Maynard Keynes famously said, markets can remain irrational longer than you can remain solvent. As one of the most influential 20th century economists, whose ideas fundamentally reshaped economic theory and policy, Maynard Keynes was right: investors need to use money they can afford to lose when investing so they do not panic when markets fall. Another point to remember: don’t use leverage – we know that markets do fall occasionally. Borrowing money to invest in assets or securities may result in margin calls or drive the investor to become a forced seller. Successful investing is about staying in the market for decades, allowing your investments to compound away. You want to be as resilient as possible.”

Stephen credits the high-profile gains of investors such as Warren Buffet with discipline. “Buffet will sit on significant cash if he does not like the valuations he is faced with investing in because, for example, the markets are at record highs. He consistently reinvests his cashflows into investments with lower valuations.”

TrinityBridge’s quantitative investment modelling favours falling stocks into which investors can reinvest dividends and coupons generated through their portfolios. Stephen points back to the summer of 2024 as an example. “The Japanese market went down 12% in just a day. The media headlines focused on a plunging stock market and an imminent recession. Our Quant Model triggered a buy level for Legal & General, a stock on our watchlist. So, rather than heed the headlines and ‘derisk’, we bought it. Two weeks later, the markets had bounced back.”

Stephen advises that cash should not only be preserved for people like Warren Buffett. “Holding some cash provides an opportunity whenever a stock trades at attractive valuations. Investment opportunities don’t come about regularly in some companies, so it’s wise to be ready for when they do. Rather than look at it as timing, it’s waiting to move at the right valuation. We may not always know the time and the stock, but when the opportunity comes, we tend to deploy money relatively quickly.”

Investing is as much about managing your mindset as it is about managing your money. By staying aware of the influences around us and focusing on the long term, you can navigate the ups and downs with more confidence. Remember, the best investors don’t predict the future, they prepare for it.